Advice on subdivision land investment

16 Replies

I am strongly considering a new type of investment for me, which is land that is to be sold to a homebuilder. I would be partnering with others in this investment within an LLC. Each of us would have a percentage share in the net proceeds. The project managers who are putting the deals together have a long, solid history in residential land entitlement and mapping and they have shared the project particulars, costs, and projected profits. On one particular deal, we are looking at an annualized return of 35% based on a projected 18-month duration, which is more like the kind of return I've been holding out for.

I'm looking for anyone that wants to play devil's advocate and tell me what I should be looking out for or what I might be missing before going all in.

Thanks in advance!

The developers might have covenants built into the title, find out if there are any and what they are. Also consider this, basically you are a partner in an enterprise, while also being an individual owner of a piece of the whole project. They are not only your partners but also your competitors and a decision taken by an individual partner might affect your investment. For example, if an individual owner decides to lower their rents or upgrade their units, you will be forced to do the same just to be on par! 35% on paper might look good, but is it really achievable? 

How much improvements are you putting in? Roads, elec, water? Biggest risk is if the lots don't sell, you are waiting a long time with no cash flow. If they start the project but don't finish, your investment is worth less than raw land... Plenty of these deals were foreclosed in the last recession.

Originally posted by @Priyanshu Adathakkar :

The developers might have covenants built into the title, find out if there are any and what they are. Also consider this, basically you are a partner in an enterprise, while also being an individual owner of a piece of the whole project. They are not only your partners but also your competitors and a decision taken by an individual partner might affect your investment. For example, if an individual owner decides to lower their rents or upgrade their units, you will be forced to do the same just to be on par! 35% on paper might look good, but is it really achievable? 

 I could be wrong but I suspect this is not a cash flow rental deal its an entitlement sell to a builder deal. so your concerns are not even close to germane but  I could be wrong of course I am many time.s

Originally posted by @Ronald Rohde :

How much improvements are you putting in? Roads, elec, water? Biggest risk is if the lots don't sell, you are waiting a long time with no cash flow. If they start the project but don't finish, your investment is worth less than raw land... Plenty of these deals were foreclosed in the last recession.

 true enough  in 05 in our market you were a rock star if you owned land that could or was entitled.. by 09it was a yoke around your neck

last 5 years we have KILLED it with entitled land far better than any buy hold would come close to doing.

Land entitlement when a sponsor goes to get funds from investors can be the most riskiest part of the process. You really have to know what you are doing.

Lot's of big builders bought out fractured or whole projects for very little cost in the last downturn. I had looked at about 6 to 7 years ago buying lots or subdivisions and holding for eventual resale but it can be risky. Until the lots sell off you have holding costs annually with property taxes, HOA fees if a fractured subdivision with some existing homes,etc.

The annual carrying costs versus what the lots would eventually sell for could have you are break even or a loss etc.

Example you buy lots for 10k each. You wait 4 years for markets to come back. Each year holding costs were 2k each lot. Year 4 you sell for 20k a lot. Basically you are almost just breaking even. The national builders are making money on the construction and sell off side.

Entitlements can be tricky because if you do not get approvals for the density and design sought then your exit values to a developer/ builder can drastically change. If this investment for you is say 100k and you are worth 3 million and make 500k a year then if the high projections do not pan out then generally you might be okay.

If you are worth 300k,investing 100k, and making 100k a year then if the deal goes bad it could sting and set you back a lot worse.  

Originally posted by @Jay Hinrichs :
Originally posted by @Ronald Rohde:

How much improvements are you putting in? Roads, elec, water? Biggest risk is if the lots don't sell, you are waiting a long time with no cash flow. If they start the project but don't finish, your investment is worth less than raw land... Plenty of these deals were foreclosed in the last recession.

 true enough  in 05 in our market you were a rock star if you owned land that could or was entitled.. by 09it was a yoke around your neck

last 5 years we have KILLED it with entitled land far better than any buy hold would come close to doing.

 Yea, I could add negative cash flow, instead of No cash flow.

Thanks everyone for the prompt feedback, totally appreciated!! --Keep it coming.ツ

@Jay Hinrichs , you are absolutely correct, it is NOT a buy and hold cash flow rental deal, rather it's an entitlement sell to a builder deal. The partners I mentioned are just investors coming in with their capital to get the deal rolling ... maybe partners is not the right word as I seemed to throw some people off. 

The PMs are doing all the work to obtain city approvals and complete all necessary studies and are projecting an 18 month turnaround to sell, at which time the investors will (hopefully) cash out. The PMs have at least over 100 similar acquisitions under their belt, so I'd say they have the necessary knowledge and experience to pull this off again and again. This particular deal will be subdivided into 40 entry-level home sites, which--compared to other much larger acquisitions in their history--is a smaller, less risky one for them. 

@Ronald Rohde , you are also correct in stating that biggest risk is that the lots are not sold. An inevitable risk we all face as RE investors. Who knows what is going to be happening 18 months from now? 

The only holding costs I can think of would be property taxes. So, worst case scenario is a downturn in the market happens and we sit on the land for a few years. ...Of course it would suck if my money wasn't working for a few years, but it wouldn't be a total loss and I would just have to wait it out (as many of us have had to do before).

The upside is that this is southern California where we have a housing shortage, and the biggest demand in RE is affordable housing. By focusing on tract homes, this project meets that demand.

Originally posted by @Elaine Hester :

@Ronald Rohde, you are also correct in stating that biggest risk is that the lots are not sold. An inevitable risk we all face as RE investors. Who knows what is going to be happening 18 months from now? 

The only holding costs I can think of would be property taxes. So, worst case scenario is a downturn in the market happens and we sit on the land for a few years. ...Of course it would suck if my money wasn't working for a few years, but it wouldn't be a total loss and I would just have to wait it out (as many of us have had to do before).

The upside is that this is southern California where we have a housing shortage, and the biggest demand in RE is affordable housing. By focusing on tract homes, this project meets that demand.

 Again I would disagree. The downside non-new construction RE investors face is liquidating an asset for a linear percentage of the purchase price, sell for 90% of price paid, sell for 75% etc. Lots have very little value without completed improvements. If your builder does a poor job or doesn't finish the job, your lots are worth significantly less 10-15% of what you paid versus 80-90% of say a multi-family.

I would argue that the CA housing shortage is an artificial creation posed by city code and development restrictions, environmental, etc. Therefore, merely having opportunity to build is not enough, you must have a developer with cash and connections to complete the permitting process. An entirely different animal that just Supply>Demand.

Look, I'm all for you investing in master developments, but want you to understand its much riskier than you seem to imply. 

@Ronald Rohde , the reason I posted this was not to talk about a great no-risk deal, but to reach out for advice and help me to see the risks I may be overlooking, so for that I do appreciate your post. Because you mentioned my builder, I'm not sure you understand the investment opportunity ... selling to a builder is the exit strategy. The investors are putting up the money to buy the land, the PMs have already done the due diligence necessary to be sure the lots can be subdivided and are buildable and will take care of city approvals so the homebuilder, once he purchases can immediately break ground and get to work. They also have a list of interested buyers in place, some whom they have worked with in the past, so they are able to develop the land with their needs in mind.

Your suggestion that the CA housing shortage was fabricated is an interesting one that I have not yet heard of or considered. I certainly have a lot to learn, but my common sense tells me that just the fact that people are willing to pay such high rents is evidence enough of a housing shortage. ...For example, although still under-market because I want to keep my tenants, the rent on a little, nothing-special-about condo I own has increased by 56% just in the last 8 years. I know my tenants want to buy, but with rising interest rates and housing prices, that dream is getting harder to reach. I'm curious what you think the reason people will continue to pay those exorbitant rent increases is if not for a shortage of affordable housing.

Originally posted by @Elaine Hester :

@Ronald Rohde, the reason I posted this was not to talk about a great no-risk deal, but to reach out for advice and help me to see the risks I may be overlooking, so for that I do appreciate your post. Because you mentioned my builder, I'm not sure you understand the investment opportunity ... selling to a builder is the exit strategy. The investors are putting up the money to buy the land, the PMs have already done the due diligence necessary to be sure the lots can be subdivided and are buildable and will take care of city approvals so the homebuilder, once he purchases can immediately break ground and get to work. They also have a list of interested buyers in place, some whom they have worked with in the past, so they are able to develop the land with their needs in mind.

Your suggestion that the CA housing shortage was fabricated is an interesting one that I have not yet heard of or considered. I certainly have a lot to learn, but my common sense tells me that just the fact that people are willing to pay such high rents is evidence enough of a housing shortage. ...For example, although still under-market because I want to keep my tenants, the rent on a little, nothing-special-about condo I own has increased by 56% just in the last 8 years. I know my tenants want to buy, but with rising interest rates and housing prices, that dream is getting harder to reach. I'm curious what you think the reason people will continue to pay those exorbitant rent increases is if not for a shortage of affordable housing.

 You're describing a master developer play, you put in roads, utilities, and subdivide, right? There's significant construction risk even without going vertical. 

There is a housing shortage, but its not due to a simple lack of supply. There are bureaucratic forces limiting builders who can waltz in with permits and "get to work" as you say. If you acknowledge that this shortage isn't new, rising rents for 8 years should have produced more housing, the answer is that there is a huge limit on supply and not just available land.

@Elaine Hester the investment you're talking about is high risk/high return. As long as you're going into it knowing that you should be fine. Best time in the cycle is late when there aren't enough available lots for builders. 

Best place is somewhere where demand is high and land is hard to come by. San Diego area would certainly count if that's where this is. Best partners are people that have been doing it a long time and have good relationships with local government officials that are under pressure to increase housing options.

If you have all of those things you are just gambling that the market will stay strong long enough to get your return.

Be careful with the 'we just sit on it for a few years'. You need to be very sure the owning entity has the financial capacity, will and agreement to do that.

Sorry @Bob @Bob Willis , I just saw your post! So, in this particular case—although it sounded like a great deal, I ended up just going with my gut and did not pull the trigger as a private placement that offered similar returns that I felt a bit more strongly about came up in Montana. To this day I do not know anything about what transpired, however, I just looked it up and see that plot of land in Riverside is still vacant and still for sale, whereas the one I chose to invest in near Bozeman, MT is on track for payoff this summer. —I have learned that sometimes you just have to go with your gut!

Elaine,
Many of our clients purchase in fill lots in residential areas. They're a great investment if you can get them at the right price because the are ready to build on for the most part.

A great place to fine in fill lots is the city and county auctions.

Good luck, great post.